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How Much Does a Full-Time Employee Really Cost?

Some companies rely heavily on contractors to staff projects and even entire departments within IT. Others exclusively prefer full-time employees. Understanding the total cost of an employee is crucial in the decision-making process. However, the ultimate decision should be based on your company or department’s business strategy. Learn more about this at Part 1 of this series: To Hire Contract or Full Time: 8 Questions to Help You Decide.

Businesses often underestimate the total cost of a full-time employee. It’s true that hourly rates are usually higher for contractors and consultants than full-time employees, but we must consider all hard and soft costs. Some are not so apparent.

Hard costs

Hourly rate – This one is easy. For this example, let’s use $75,000 per year as a pay rate, which equates to slightly more than $36 per hour for 2,080 hours per year. One key difference with contractors is you only pay for productive hours. Full-time employees are paid during non-productive hours, such as vacation, holidays and sick time.

Statutory costs – Social Security and Medicare cost employers 7.65% of a base salary plus federal and state unemployment insurance. For a $75,000 employee, this equates to more than $3 per productive hour worked.

Employee benefits – Full-family benefits such as health care costs, which rise each year, and 401k matching can equate to $8 per productive hour worked.

Training costs – The actual amount per employee depends on the type of job and varies from company to company. It is estimated that the cost per hour worked ranges from $0.50 to $2.50. Using contractors or consultants allows you to avoid paying for training courses, conferences, subscriptions and certifications.

Training time – Contractors and consultants are paid for hours worked. Companies pay only for the value created and not when a contractor is focused on non-productive tasks. Five days of training per year equates to nearly $2,000 in lost productivity for an employee making $75,000. As such, use of a contractor abates approximately $1 per hour of training expense.

Vacation time – Like training, vacation cost is abated by using contractors. Depending on your time-off policy, you can avoid two to three weeks of cost. Two weeks of vacation equates to $4,000 per year for an employee making $75,000 or approximately $2 per productive hour. In addition, paid breaks can amount to an additional two to four hours per week.

Paid holidays – Most companies offer approximately ten days of paid holiday time, equating to $4,000 per year or $2 per hour.

Sick time – Depending on your policy, you may avoid the cost of between 5 and 10 sick and/or personal days. This equates to $2,000 to $4,000 per year or $1 to $2 dollars per productive hour worked.

Bad hire costs – Bad hires are expensive. Studies indicate that the cost of a bad hire is two and a half to three times the employee’s salary. This cost is avoided with contractors, who can be terminated with little headache if things don’t work out. If one in thirty hires is a bad one, then we should increase the hourly rate by 10% per productive hour work.

Hiring costs – Hiring is an expensive process. Significant management time is invested in gathering resumes, screening resumes, making calls to candidates, testing, scheduling interviews, conducting interviews, evaluating and choosing a candidate, negotiating the offer, and repeating the process if the candidate does not accept. These costs can be reduced by using contractors. This management and human resources time can be focused in areas of greater value to the business. For the purposes of this example, I’ve included no allocation for hiring costs.

Separation costs – The unfortunate situation where you choose to terminate an employee creates costs for the company. If the employee is laid off, severance costs are avoided. If the termination is performance-based, all of the time invested by HR and management on counseling, deliberations and termination are avoided. While incurring these costs are not certain, by using contractors you avoid this risk. For the purposes of this example, I’ve included no allocation for separation costs.

For a $75,000 resource, hard costs equate to approximately $22 per productive hour worked or nearly $40,000 per year!

Soft Costs

Soft costs are more difficult to quantify. The opportunity cost of time spent managing employees from a human resources perspective is the most often overlooked and underestimated employee cost. Contractors and consultants do not require a career path, training plans, performance appraisals or counseling sessions. It is estimated that up to 15% of a manager’s time is spent in these areas.

By using contractors and consultants, management time can be focused in areas of greater potential value to the business. One industry benchmark shows that day-to-day management and other soft costs equate to an additional 25% of an employee’s total cost.

Of note, decision makers correctly consider management costs as fixed…they are not avoided when using contractors instead of full-time employees. Unfortunately that misses the point. I’m specifically calling out the opportunity cost of management time, which can be focused in higher ROI areas.

Totaling it up

The total cost of an employee making $75,000 per year is approximately double – nearly $150,000 per year.

While using a contractor is definitely not appropriate for every situation, it’s not as expensive as it sometimes seems. As such, our recommendation is to base your decision to use full-time or contract resources on business strategy, not hourly pay rates.

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8 thoughts on “How Much Does a Full-Time Employee Really Cost?”

I don’t think you are doing the math right neither are you focusing on the problem. The key to a hiring decision is the question why hire anyone? consultant or employee and a common answer is one person can not do it all.
If seen from this perspective, the numbers look a lot different. The process of hiring an employee and all the management spend is to keep that person involved in the focused effort of growing the company.

Mark my words,

A Consultant will NEVER (99.99%) follow or advice a path to follow that gets them out of there.

I have seen examples of these to nth degree where a consultants drag feet by offering more of the same while the premise of the process is change.

This whole old school calculation is not only wrong but a worst possible choice for any company. Consulting is strictly short term staffing, if you ever need a consultant for more than a few months (6-8) then you have a problem that you need to fix and for the most part that consultant will neither fix that problem nor will they help you fix that problem, to top it all they just might hide it under the carpet, play politics to misguide you or create other distractions to keep you occupied worst, give you big misguided dreams that completely set you on a wrong path, ANYTHING as long as you pay the consulting company..

Dheeraj, Wow. It sounds like you’ve had some pretty bad experiences with consultants. I definitely don’t agree with most of the generalizations that you are making. Here are my comments to your comments …

First, I’m pretty certain that the math is correct but if you see a math error, please let me know and I’ll correct.
Second, using contractors (and please note that I’m specifically referring to contractors, not consulting engagements) still requires management to ensure that the tasks, project, or functions are being performed adequately at the least. Oversight prevents much of what you’ve seen and articulated.
Third, contract staffing companies have the interest of the client in mind. If the contractor is not performing, then the contract staffing company works to put the right person in place … who can perform and fit with the organization. That said, any vendor should have the client’s interests AND their reputation in mind. As such, most of the consulting companies that I’ve worked with pay very close attention to being on-time and on-budget.
Forth, we have many clients (and I would consider that a representative sample of a very large set) who use contractors exclusively for specific functions not only long-term but perpetually. In these cases, the decision fits within their business plan on how they operate their business, and is culturally compatible with their organization.

Last, the decision to hire, use a contractor, engage consultants, or outsource to a managed service has to be rooted in the business strategy of the company or department. I wrote a blog on that last week and encourage you to check it out if you have not already. Framed that way, the appropriate management would be allocated and expectations set to maximize the chance of successful execution of the plan.

Henry, What can I say? Not all contract staffing companies are equal. How many others have a blog like http://www.3coast.com? Perhaps I should have written, “Third, good contract staffing companies have the interest of the client in mind.”

“Third, contract staffing companies have the interest of the client in mind”
Really ? I do not think so . I have been with 4 staffing companies as a contractor. It seems like they only care about my time sheet so they can collect money on time.

Wow, pretty one sided article there. Might want to at least point out a few of the benefits of the full-time employee route. The most obvious one is that if you continually go the contract route you’ll have an employee who is interested in short term goals rather than the long term stability of the company. Then throw in the fact that you’ll be continually training (policies, procedures, business processes) said contract employees vs. having a full timer who once you train them they’ll retain that knowledge.

Kevin, the main idea of this post is that the monetary cost, including both hard and soft costs, of a contractor and an employee are pretty comparable. Are there pros and cons of each? Absolutely. As you allude, many are rooted in the differing incentives and “unintended consequences” of those incentives. I’m not advocating that using contractors is ideal in every case. I’m actually not advocating anything in particular … I hope that you check out my previous blog post, Part I, which proposes that the decision of whether to hire or use contractors should be rooted in business strategy. http://www.3coast.com/to-hire-contract-or-full-time-8-questions-to-help-you-decide/ I hope that you’ll find that posting useful.

Stephen did make the point in this post that if you are using contractors for more than 6 months, then the position should really be reconsidered as a regular rather than temporary position. I prefer the term “regular” over “full-time” as there are comparatively regular part-time positions these days. I am certainly not looking at paying any of my employees $75,000 per year for the type of work done as the entry educational (expertise) requirements are nowhere near justifying that rate, particularly in my state (Ohio). Obviously employee costs vary from state to state due to state requirements, taxes, etc, but expecting a total annual cost of up to double the annual pay of each employee may well be a very safe estimate.

Thanks Ian for your comment. This has been a popular post on 3coast with over 2500 views since it was originally posted. I guess lots of people are interested in understanding the relative cost and how to choose contractor vs. full-time.

We continue to keep a pulse on our client’s views toward hiring vs. using contractors.

Nothing has changed since the original post, specifically … whether to use a contractor has more to do with client’s employee culture, the client’s industry, and the nature of the position (strategic vs. operational; temporary vs. long-term) , and less to do with the relative costs … which seem to be “roughly” equivalent when you tally hard and soft costs.